Question 1

In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity.

Accepted Answer

A)   greater than
B)   equal to
C)   less than
D)   proportional toE) A) and B)
F) A) and C)

Question 2

According to the efficient markets hypothesis, the current price of a financial security

Accepted Answer

A)   is the discounted net present value of future interest payments.
B)   is determined by the highest successful bidder.
C)   fully reflects all available relevant information.
D)   is a result of none of the above.E) All of the above
F) None of the above

Question 3

Excessive volatility refers to the fact that

Accepted Answer

A)   stock returns display mean reversion.
B)   stock prices can be slow to react to new information.
C)   stock price tend to rise in the month of January.
D)   stock prices fluctuate more than is justified by dividend fluctuations.E) None of the above
F) B) and D)

Question 4

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Accepted Answer

A)   A stock that has done poorly in the past is more likely to do well in the future.
B)   One investment is as good as any other because the securities' prices are correct.
C)   A security's price reflects all available information about the intrinsic value of the security.
D)   Security prices can be used by managers to assess their cost of capital accurately.E) A) and D)
F) A) and C)

Question 5

Evidence in support of the efficient markets hypothesis includes

Accepted Answer

A)   the failure of technical analysis to outperform the market.
B)   the small-firm effect.
C)   the January effect.
D)   excessive volatility.E) B) and C)
F) A) and D)

Question 6

If expectations are formed adaptively, then people

Accepted Answer

A)   use more information than just past data on a single variable to form their expectations of that variable.
B)   often change their expectations quickly when faced with new information.
C)   use only the information from past data on a single variable to form their expectations of that variable.
D)   never change their expectations once they have been made.E) B) and D)
F) C) and D)

Question 7

The value of any investment is found by computing the

Accepted Answer

A)   present value of all future sales.
B)   present value of all future liabilities.
C)   future value of all future expenses.
D)   present value of all future cash flows.E) None of the above
F) B) and C)

Question 8

________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity.

Accepted Answer

A)   Arbitrage
B)   Mediation
C)   Asset capitalization
D)   Market intercessionE) All of the above
F) None of the above

Question 9

In asset markets, an asset's price is

Accepted Answer

A)   set equal to the highest price a seller will accept.
B)   set equal to the highest price a buyer is willing to pay.
C)   set equal to the lowest price a seller is willing to accept.
D)   set by the buyer willing to pay the highest price.E) A) and B)
F) None of the above

Question 10

In the generalized dividend model, if the expected sales price is in the distant future

Accepted Answer

A)   it does not affect the current stock price.
B)   it is more important than dividends in determining the current stock price.
C)   it is equally important with dividends in determining the current stock price.
D)   it is less important than dividends but still affects the current stock price.E) A) and C)
F) A) and B)

Question 11

In the Gordon growth model, a decrease in the required rate of return on equity

Accepted Answer

A)   increases the current stock price.
B)   increases the future stock price.
C)   reduces the future stock price.
D)   reduces the current stock price.E) All of the above
F) B) and C)

Question 12

The efficient markets hypothesis indicates that investors

Accepted Answer

A)   can use the advice of technical analysts to outperform the market.
B)   do better on average if they adopt a "buy and hold" strategy.
C)   let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.
D)   do better if they purchase loaded mutual funds.E) A) and D)
F) B) and C)

Question 13

Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is

Accepted Answer

A)   clearly inconsistent with the efficient markets hypothesis.
B)   consistent with the efficient markets hypothesis if the earnings were not as high as anticipated.
C)   consistent with the efficient markets hypothesis if the earnings were not as low as anticipated.
D)   consistent with the efficient markets hypothesis if the favorable earnings were expected.E) None of the above
F) C) and D)

Question 14

The efficient markets hypothesis predicts that stock prices follow a "random walk." The implication of this hypothesis for investing in stocks is

Accepted Answer

A)   a "churning strategy" of buying and selling often to catch market swings.
B)   turning over your stock portfolio each month, selecting stocks by throwing darts at the stock page.
C)   a "buy and hold strategy" of holding stocks to avoid brokerage commissions.
D)   following the advice of technical analysts.E) A) and B)
F) B) and C)

Question 15

Using the Gordon growth formula, if D1 is $1.00, ke is 10% or 0.10, and g is 5% or 0.05, then the current stock price is

Accepted Answer

A)   $10.
B)   $20.
C)   $30.
D)   $40.E) All of the above
F) C) and D)

Question 16

The view that expectations change relatively slowly over time in response to new information is known in economics as

Accepted Answer

A)   rational expectations.
B)   irrational expectations.
C)   slow-response expectations.
D)   adaptive expectations.E) All of the above
F) A) and C)

Question 17

In rational expectations theory, the term "optimal forecast" is essentially synonymous with

Accepted Answer

A)   correct forecast.
B)   the correct guess.
C)   the actual outcome.
D)   the best guess.E) All of the above
F) C) and D)

Question 18

In the one-period valuation model, an increase in the required return on investments in equity

Accepted Answer

A)   increases the expected sales price of a stock.
B)   increases the current price of a stock.
C)   reduces the expected sales price of a stock.
D)   reduces the current price of a stock.E) A) and C)
F) A) and B)

Question 19

You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor

Accepted Answer

A)   may or may not be better than the other forecasts. Past performance is no guarantee of the future.
B)   will always be the best of the group.
C)   will definitely be worse in the future. What goes up must come down.
D)   will be worse in the near future, but improve over time.E) All of the above
F) C) and D)

Question 20

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Accepted Answer

A)   A stock that has done poorly in the past is more likely to do well in the future.
B)   One investment is as good as any other because the securities' prices are correct.
C)   A security's price reflects all available information about the intrinsic value of the security.
D)   Security prices can be used by managers to assess their cost of capital accurately.E) A) and B)
F) B) and C)

Exam 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis

According to the efficient markets hypothesis, the current price of a financial security

Correct AnswerverifiedShow Answer

In the Gordon growth model, a decrease in the required rate of return on equity

Correct AnswerverifiedShow Answer

The value of any investment is found by computing the

Correct AnswerverifiedShow Answer

If expectations are formed adaptively, then people

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You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor

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The efficient markets hypothesis indicates that investors

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In the one-period valuation model, an increase in the required return on investments in equity

Correct AnswerverifiedShow Answer

The efficient markets hypothesis predicts that stock prices follow a "random walk." The implication of this hypothesis for investing in stocks is

Correct AnswerverifiedShow Answer

In asset markets, an asset's price is

Correct AnswerverifiedShow Answer

________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity.

Correct AnswerverifiedShow Answer

Using the Gordon growth formula, if D1 is $1.00, ke is 10% or 0.10, and g is 5% or 0.05, then the current stock price is

Correct AnswerverifiedShow Answer

Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is

Correct AnswerverifiedShow Answer

The view that expectations change relatively slowly over time in response to new information is known in economics as

Correct AnswerverifiedShow Answer

Evidence in support of the efficient markets hypothesis includes

Correct AnswerverifiedShow Answer

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Correct AnswerverifiedShow Answer

Excessive volatility refers to the fact that

Correct AnswerverifiedShow Answer

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Correct AnswerverifiedShow Answer

In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity.

Correct AnswerverifiedShow Answer

In rational expectations theory, the term "optimal forecast" is essentially synonymous with

Correct AnswerverifiedShow Answer

In the generalized dividend model, if the expected sales price is in the distant future

Correct AnswerverifiedShow Answer

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Using the Gordon growth formula, if D₁ is $1.00, k_e is 10% or 0.10, and g is 5% or 0.05, then the current stock price is

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